a set of rules and strategies you can follow all the time. In order to be able
to follow those rules and strategies, you’ll need to be totally comfortable
with them. If you start doubting or second-guessing them, you put yourself
at risk. For example, you may like trading with the trend and are looking
at a trade in a strongly trending stock. Others are telling you it’s about to
reverse and that you should short it. They may give you several reasons and
show you indicators why it will happen. You may soon start rationalizing
why it may go down as you weigh all the information, even if it’s against
your style.
So let’s say you listened and went short, but then it doesn’t reverse
immediately. Now your gut may start telling you what a fool you were to
listen, and you start panicking because this is not your type of trading and
the stock is still strong, so you get out quickly. However, the market soon
peters out and takes a nosedive. You lose money on the trade, yet the people
who convinced you to short all did well on it. Why? Because they traded
their style and you traded against your style. You can see how this could
happen in Figure 4.1. The shaded oval in this chart is where the action is
taking place. I’ve added a blown up picture of the chart in Figure 4.2, which
will help you to see it better.
Let’s say Harry (the good trader) looking for the market to reverse
saw a sign at spot A. He saw the large spread between his two moving
FIGURE 4.1 Daily Chart of SLB
Source: © TradeStation Technologies 1999. All rights reserved.
averages, which led him to believe the market might retrace a bit to narrow
that spread. He also saw that both the stochastics indicator and RSI were
overbought, giving the market a good chance to come off. He saw that the
market closed on its high the day before and failed to follow through the
next day. He rationalized that if we had just a little bit of a sell-off, the indicators
could all turn, making for a great short. So he decided he would short
on the next morning if the market opened weaker. He shorted at a level
indicated by oval A. He would use a stop two points above the high made
the day before (indicated by the line marked Stop). John (who never makes
money) on the other hand went against his gut to short the stock on Harry’s
suggestion. He looks at the chart and sees a strong uptrend and deep inside
feels funny shorting. Though John decided to make the trade based on a
little peer pressure, he couldn’t handle the strong opening a few days later
(oval B) and got out. Harry, however, had his stop in so he did nothing. He
noticed the divergence between the market and the indicators, which led
him to believe that this might be a false rally, so he let his trade ride. The
divergence between the slope of indicators and market is a little hard to
see in the blown-up chart. But the market peaked while the indicators did
not, making for a great indication that this uptrend could be dying out. The
FIGURE 4.2 Close Up of the SLB
Source: © TradeStation Technologies 1999. All rights reserved.
market opened strong but then sold off the rest of the day, week, and
month, making a nice trade for Harry. This is a great example of why it
is hard to trade against your style of trading. As soon as something doesn’t
go your way you will be double guessing yourself and will have trouble
allowing a trade to develop.
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